Herbert Smith (A Firm) v David Stanley Honour and Another
| Jurisdiction | England & Wales |
| Judge | Mr. Justice Lloyd,The Hon. Mr. Justice Lloyd |
| Judgment Date | 12 February 1999 |
| Judgment citation (vLex) | [1999] EWHC J0212-8 |
| Court | Queen's Bench Division (Administrative Court) |
| Docket Number | CH 1997 H NO. 5996 |
| Date | 12 February 1999 |
[1999] EWHC J0212-8
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
The Hon. Mr. Justice Lloyd
CH 1997 H NO. 5996
Edward Walker-Arnott, Senior Partner, for himself and the other partners in the Appellant Firm
Nicholas Warren Q.C. and Rabinder Singh instructed by the Solicitor of Inland Revenue for the Respondent
Hearing dates: 30 November, 1 and 2 December 1998, 12 February 1999
I direct that pursuant to RSC Order 68 r. 1 no official shorthand note shall be taken of this judgment and that copies of this version as handed down may be treated as authentic.
Introduction
Messrs Herbert Smith (the "Firm") carry on the profession of solicitors from offices in a number of places. In 1989 they had four offices in London, all held by way of lease. In the autumn of that year they decided to move to a single office. They agreed to take a lease of Exchange House, Primrose Street, Broadgate. On 26 January 1990 this agreement became unconditional and the lease was granted. By the end of 1990 they had vacated their four existing offices and moved to Exchange House. That put into effect a decision which had already been made, when the new lease was granted, to abandon the four existing offices as soon as the move took place. In relation to two of the four offices they were able to put an end to their continuing obligations for rent: one lease was terminated by notice (Walker House) and the other (Watling House, Cannon Street) was assigned at a premium of £750,000. The two other leases, however, were at rents which were well above the then level of the market, and they were not capable of being terminated. They were therefore left with these two leases, one of which was to expire in 1992 (52 Cannon Street) and the other not until 2008 (20 Cannon Street), expecting (as has turned out to be the case) that if they could sublet them at all it would only be for a lower rent than they had to pay under their own leases. They would be out of pocket for the foreseeable future.
The Firm has its accounts audited in accordance with the principles that would apply if it were a company, so as to show a true and fair view both of the affairs of the partnership at the balance sheet date, and of the partnership's profit and source and application of funds for the year. The auditors were Messrs BDO Binder Hamlyn. In the accounts for the 12 month period to 30 April 1990 (the "Basis Period"), a provision of £5,511,258 was made for the expected loss on these two leases, in one case for the remainder of the lease and in the other until 1998 (the date of a rent review, beyond which the position could not be reliable forecast). That is the basis on which the rights and obligations of the partners between themselves have been regulated. In particular partners retiring on 30 April 1990 suffered the reduction of their profit shares by the making of this provision.
The accounts deal with the matter by reference to a note which includes the following passage:
"Until such time as the leases on the remaining two premises are disposed of, the Firm will continue to be liable for the rent and associated costs for these premises. The estimated costs and revenues relating to these premises following their vacation have, in accordance with standard accounting practice, been accrued for the year in which the decision to relocate was taken, i.e. the year to 30 April 1990. A net provision of £4,761,258 has therefore been established in these accounts, being the costs of the on-going leases from the date of vacation to the expected date of disposal (estimated by our professional advisers to be £5,511,258) less the proceeds on disposal of one of the leases (£750,000 received in January 1991)."
The estimate was, as it turned out, over-optimistic, and the shortfall has been greater. Further provisions have therefore been made in later years. The occurrence of the 1998 rent review made it possible to forecast the position for the remaining period of the lease, and this has also led to a further provision.
The Inland Revenue, however, contends that, although this is a, or indeed the, proper approach as a matter of the generally accepted principles of commercial accounting, and a fair approach as between the Firm's partners, new, continuing and retiring, nevertheless for income tax purposes the Firm's profits for the Basis Period must be regarded as not subject to the deduction of anything (in respect of the rental liability on the two leases) other than the rent for the premises falling due during that period itself, and that to make provision for future rent liability anticipates losses in a way which is not legitimate in the assessment of the Firm's income for tax purposes. The Special Commissioners accepted the Revenue's submissions, and the Firm now appeals.
It is not in dispute that the Firm is entitled to deduct the shortfall between the rent payable under these two leases and the smaller rent obtained on sublettings of the premises, even though the premises are no longer used for the purposes of the profession. The dispute is as to whether the shortfall is to be deducted in advance by way of these provisions, or rather year by year as it occurs.
The legal issue is what is to be brought into account in respect of the net rent payable for these premises when calculating "the full amount of the profits or gains of the year", those profits being the annual profits "arising or accruing … from any trade, profession or vocation": see Income and Corporation Taxes Act 1988 s.60(1), and s.18(1). Mr. Edward Walker-Arnott, Senior Partner of the Firm, arguing the appeal on its behalf, contended that the amount in any given year of the profits of a partnership which has its accounts prepared and audited on generally accepted principles of commercial accountancy is the profits shown by those accounts for that year. He submits that there is only very limited scope for going behind those accounts, and that this is not an instance in which, according to the cases, that can be done.
As a matter of partnership law, there is a new firm each year, some partners retiring and others being admitted. That points to the need to deal fairly as between different partners, new, continuing and retiring. The "true and fair" approach to the Firm's accounts is no doubt designed for this purpose. The accounts are not published. Company accounts, which are published, have to be prepared on a true and fair basis for the benefit of actual and potential investors and creditors. There are differences between what may be appropriate for the purposes of public disclosure and the considerations of tax law. So far as partnerships are concerned, matters which are relevant particularly to new or to retiring partners are not relevant for tax purposes, because in the case of an ongoing business such as that of the Firm, the partners make elections each year under Income and Corporation Taxes Act 1988 section 113 for the partnership's affairs to be dealt with on a continuing basis. Thus for tax purposes the partnership is treated as if it were in the same position as a corporate entity, unaffected by its changing membership.
I must record my indebtedness to Mr. Walker-Arnott and Mr. Warren Q.C. for the Respondent for their cogent and well-argued submissions. I admit to having found the resolution of the issues far from easy. This, together with the time required for other judicial commitments, has contributed to the fact that this judgment is delivered much later than I wished or intended.
Generally accepted principles of commercial accounting
In relation to almost any business which is carried on over more than one accounting period, questions arise as to whether particular items, whether of receipt or of expenditure, should be attributed to one period rather than another. One of the functions of the principles of commercial accounting is to help towards answers to these questions which are consistent, which reflect the commercial reality and which are readily understandable by a reasonably well-informed reader of a particular set of accounts. A major contributing factor to this has been the development and publication of accounting standards, in particular the series of Statements of Standard Accounting Practice. There is no SSAP which deals with the specific question arising in the present case, but the fundamental accounting concepts described in SSAP2 are at the heart of the case as it has been approached by the taxpayers, by their expert witness and by the Special Commissioners. SSAP2, issued in 1971, remained applicable at the relevant time. The following are among the more directly relevant passages:
Paragraph 2:
"Fundamental accounting concepts are here defined as broad basic assumptions which underlie the periodic financial accounts of business enterprises. It is expedient to single out for special mention four in particular: (a) the 'going concern' concept, (b) the 'accruals' concept, (c) the 'consistency' concept and (d) the 'prudence' concept. The use of these concepts is not necessarily self-evident from an examination of accounts, but they have such general acceptance that they call for no explanation in published accounts and their observance is presumed unless stated otherwise. They are practical rules rather than theoretical ideas and are capable of variation and evolution as accounting thought and practice develop, but their present generally accepted meanings are restated in paragraph 14 below."
Paragraph 5:
"The main difficulty in applying the fundamental accounting concepts arises from the fact that many business transactions have financial effects spreading over a number of years. Decisions have to be made on the extent...
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